Human Rights Promotion (18): To What Extent Can We Count on the Free Market?

Why not use the free market to promote human rights? The free market – or the market for short – is the name of the institution, protected by government rules, which allows individual or collective agents such as firms to freely exchange goods and services. Agents exchange things in the market for self-interested reasons and they tend to use money as the medium of exchange, but that doesn’t mean we’ll only see greed and accumulation of wealth resulting from the operation of the market. I’ll show that we can, to some extent, count on the market to further the cause of human rights.

But let’s start by complicating things a bit:

• The market can either benefit or harm human rights.
• And human rights can either benefit or harm the operations of the market.

Hence, the relationship between market and rights is difficult, to say the least. Here are a few examples:

Some human rights are a direct benefit to the market. Take for example the right to private property. This is a human right and it’s one that is generally conceived to be essential for the efficient operation of a market (some even argue that this right justifies free markets, but I want to sidestep issues of justification here and focus on consequences). You can construct a similar argument in the case of other rights such as the right to free movement, to assembly etc. At other times, however, human rights can hinder the market: privacy is a human right but privacy can cause asymmetrical information which in turn causes market dysfunctions.

Markets can have a similar two-sided effect on human rights. Conventional wisdom says that the market is the institution that delivers the highest possible level of prosperity, compared to other ways of organizing the economy. Higher prosperity may benefit certain specific human rights such as the right not to suffer poverty, the right to work etc. This benefit may occur because additional wealth “trickles down” or because additional wealth means additional redistribution. In general, it’s the case that rights cost money, so increased prosperity should, all else being equal, lead to increased rights protection across the board.

A more indirect way in which the market benefits rights is through it’s focus on individualism: the market – as opposed to a centrally planned economy – allows individuals to choose when and what to trade. Individual freedom is also at the heart of human rights. Some have also argued that the rational self-interest that is typical of people engaging in market transactions counters some dangerous and often violent passions such as xenophobia, nationalism and racism. If people trade with one another, they may become more tolerant of one another, if only because trade requires contact, respect, trust and peace. Tolerance and peace are of course also beneficial to human rights. And, finally, both the market and human rights requires the rule of law. If markets foster the rule of law, then that will benefit rights as well.

However, other aspects of markets can harm human rights. A strict interpretation of property rights – something we often hear from defenders of the market – may make redistribution difficult if not impossible, and some rights depend sometimes on redistribution. Think again of the right not to suffer poverty. More generally, markets can have two types of effects that may harm human rights indirectly:

• Markets tend to “colonize” areas of life where an exchange of things for money is perhaps not the best way to proceed. Some goods can only be valued when they are shared rather than exchanged (e.g. art). In other cases, exchanging goods can destroy their value (e.g. political votes), just as pricing goods can destroy their value (e.g. gifts). I can also mention some types of commodification of the body such as prostitution or organ trade. While commodification of the body is not necessarily a rights violation in itself, it does devalue the dignity of human life. People are treated as means rather than ends, and a devaluation of human beings makes human rights violations more likely.
• In some sense, this instrumentalization of the other is inherent in all market transactions, not just those in which bodies or body parts are traded. Market transactions are by definition self-interested and impersonal. We only buy or sell when that makes us better off and we don’t need to get to know our buyers or sellers. We use them simply to satisfy our needs. While self-interest and lack of personal relationships in one area of life do not necessarily harm relationships, communities, caring and common deliberation on the public interest in other areas, they can do so when markets “colonize” those other areas.

And, finally, there’s the risk of exploitation in market transactions, which I have discussed here.

I’m more interested in the effects of the market on human rights than in the effects of human rights on the market. Human rights are the ultimate good, and markets are generally a means (at best, markets are one form of exercise of certain human rights). Since the effects of the market on rights can go either way, the question becomes one of limits. If the market harms human rights, or if it expands into areas where market-transactions can indirectly harm human rights, then we have good reasons to limit the operations of the market. However, when doing so we must take care not to go too far and undo the positive effects of markets.

These limitations don’t always have to be of a legal nature. A good public education system can create a culture that helps to keep markets in their place. Governments can acquire art collections and thus remove them from the market. Or they can promote organ donation in various ways (e.g. reciprocity and presumed consent) so that organ shortages don’t force people into markets (legal or illegal markets). Welfare can help poor people avoid exploitative market transactions. And so on. However, legislation is often unavoidable if we want to protect rights against the market.

More posts in this series are here.

The Ethics of Human Rights (66): Human Rights and “Spontaneous Order”

Hayek has famously argued that market economies create a spontaneous order, a more efficient allocation of societal resources than any intentional design or planning could achieve. This spontaneous order is superior to any order the human mind can design due to the specifics of the information requirements. Planners will never have enough information to carry out the allocation of resources reliably. Only individual economic actors can create an efficient and productive economy by engaging in free exchanges and by using as their information source the spontaneously developing price system. They can do so because they act on the basis of information with greater detail and accuracy – namely the price system – than the information available to any centralized authority.

Whatever the general merits of such invisible hand theories for the whole of society (I think those merits are real but often vastly overstated), it’s useful to ask if they also apply in the field of human rights. To what extent and in which circumstances can there be an equivalent of “spontaneous order” for human rights? Can it happen that people’s unintended and selfish actions promote respect for human rights? Or do human rights always require intentional and (centrally) planned policy?

First, this question has to be distinguished from a similar one: it’s true that people do have selfish reasons to promote human rights and often act on those reasons, as I’ve argued here. But in that case their human rights efforts are quite intentional. What I’m asking here is whether there are equally selfish but unintentional processes that promote human rights. And I think there are. Before listing some of them, however, let me make clear that those processes, although they are obviously beneficial and to be encouraged, will not make a huge difference, and that they certainly won’t be sufficient to bring about human rights utopia.

After some superficial thinking about this, I came up with three examples:

• Trickle down economics is by now thoroughly discredited, especially when it’s used to justify tax cuts for the wealthy. Not all boats have risen on the rising tide, and the tide itself has recently come crashing down on all of us, the rich included. However, that doesn’t mean that there’s never any trickling down in an economy. When the government’s tax system allows the wealthy to retain a reasonable part of their wealth (let’s assume we know what “reasonable” means here), then some of their wealth does indeed flow down to those with lower incomes. That’s because the rich are more likely to spend the additional income, through either consumption or investment, thereby creating more economic activity, which in turn generates jobs and higher income for the less well-off. If that’s the case, then the right to a certain standard of living is promoted through the selfish and unintentional actions of the wealthy. Of course, this will never be enough to secure that right for everyone all of the time.
• As Becker has argued, free competition between firms reduces discrimination. A racially biased firm will want to hire whites, even if they are more expensive and less qualified than some non-whites. But a firm will only do so if it’s not under pressure from competitors. In a competitive market, other firms can and will produce the same goods at cheaper prices by hiring the cheaper/better black person. The biased firm will then be forced to do the same. It may remain biased – opinions on such matters are notoriously hard to change – but it no longer has the luxury of acting on its bias.
• There’s a strong tendency towards urbanization in developing countries. Large cities offer more economic opportunities, and jobs in factories, shops or trade offer some advantages compared to agriculture (e.g. weather independence, stable income etc.). When women move to cities and work in factories, they usually have less children – they don’t need children to work the land – and they become more independent of traditional patriarchal structures that are more common in the countryside. This does not only improve the wellbeing of women. Having less children means that the remaining children are more likely to attend school, because school is expensive. Female children in particular benefit from this education. Hence, rights such as education and non-discrimination are automatically advanced by urbanization.

More posts in this series are here.

Measuring Poverty (14): Measuring Income Inequality

Income inequality may or may not be the best definition of poverty,  but it’s certainly one that is often used. In many European countries, you’re counted as poor when your income is below 50% or so of the median income. Maybe this is the wrong way to measure poverty, but if you use absolute measures for poverty (such as a basic income, minimum consumption etc.) you’ll also face some problems. So it’s worthwhile to examine some of the usual methods for measuring income inequality and see how they hold up, while at the same time bracketing the discussion about poverty as either absolute deprivation or unequal distribution.

Methods for measuring income inequality

The Gini coefficient is the most widely used. It’s based on the proportion of the total income of a population that is cumulatively earned by a % of the population; a value of 0 expresses perfect equality where everyone has equal shares of income and a value of 1 expresses maximal inequality where only one person has all the income. A low Gini coefficient indicates therefore a more equal distribution. (The complete formula is here).

A disadvantage of the Gini measure is that it doesn’t capture where in the distribution the inequality occurs: is a society unequal because the top 1% has astronomically high incomes, because the poor are very poor, because there is practically no middle class, or because of some other reason?

Other measures are

• the ratio of the incomes of the top 10% (best paid) to the bottom 10% (worst paid)
• the proportion of a population with income less than 50% of the median income
• a population may be split into segments, e.g. quintiles or deciles, and each segment’s income share is then compared to each other segment’s (for example, the top 10% of the population – “top” in income terms – has x % of total income)
• some other measures are here.

These different measures can give contradictory numbers: two societies with the same Gini score can have different ratios of top-bottom, top-middle or middle-bottom incomes (see an example here). Hence, no single measure will tell us the last word about inequality in a society.

What is income?

The focus of all these measurement systems is income, but we should first decide what to count as income. Income doesn’t have to be cash or currency. A farmer in a poor country who grows his own products has non-cash income. Perhaps public services such as healthcare or education should count as income. And how about tax reductions, tax refunds, government benefits such as unemployment insurance, food stamps and various vouchers?

All those forms of non-cash or non-labor income are important when measuring income inequality because the poor profit disproportionately from those non-cash or non-labor related forms of income. Hence, including them in total income can make a large difference in income inequality numbers. (Higher income groups may have less or different tax refunds and their education may represent a smaller portion of their total income – the returns of their education may of course be higher, but those returns are typically cash based in the sense that they lead to higher labor compensation).

We should also decide if we want to use income before or after taxation; depends if we want to measure the effectiveness of redistribution or simply gross inequalities. And what about capital gains, imputed house rents from home ownership, inheritance etc. In general, how should wealth be included in income? Or shouldn’t it be?

How do we measure income?

Once we’ve solved the difficult problem of defining income, we’re still left with the practical problem of measuring it. Most cash income is captured in tax return data, but not all, and not equally well in all countries. Sometimes, you’ll need to use consumption data as a proxy for income data, or surveys about living standards. “Informal” income typically does not show up in tax data, but does in consumption data.

Another problem with measures of inequality is that they may be contaminated by notions of fairness. Some deliberately design their measurement system in such as way that inequalities look bigger than they actually are. For example, they use pre-tax inequalities because those are often larger than post-tax inequalities – a lot of tax systems are redistributive towards the poor (e.g. progressive taxation systems). Or they focus on income inequality when consumption inequality may have diminished. Others may mistakenly deduce evaluations of fairness or injustice from the simply fact of income distributions and forget that measures of income inequality are silent about who is on which side of the divide. If person A in a two person economy has twice the income of person B, then the measurement of inequality would be absolutely the same when B switches places with A. Measures of income inequality say nothing about who deserves what, about how income has been acquired, about whether some occupations should yield higher compensation (for example because we want the right incentives), or about how income should ideally be distributed.

And then there is the opposite mistake: assuming that income inequality is always necessary and just because it’s the automatic result of the fact that people have different levels of human capital and productive abilities. This is a mistake because it ignores a number of facts: no one has ever been able to prove that some abilities or occupations deserve higher wages from a moral point of view, and a lot of inequality is the result not of different abilities or efforts but of differences in luck and connections. Hence, fairness remains a legitimate concern. Contrary to the “left-wing mistake”, the “right-wing mistake” will not distort the measurement of inequality: if you believe inequality is not a problem you hardly have a reason for measuring it, let alone distort the measurement.

What I want to stress is how difficult it is to measure income inequality and how many mistakes we can make. This doesn’t mean that the numbers are rubbish. We should just be careful when drawing sweeping conclusions, that’s all.

Something more about the causes of income inequality, rather than the measurement of it, is here.

The Causes of Poverty (53): Poor Economic Growth

As an update of this previous post, here’s some more information about the nature of the relationship between economic growth and poverty reduction.

In a recent paper, Lane Kenworthy has compared growth and income data for 17 developed countries. Specifically, he looked at the ways in which the incomes of people in low to middle income groups benefit from economic growth. “Growth” here means increases in the amount of per capita GDP – this caveat is necessary in order to filter out economic growth that is the result of population growth and that doesn’t make the average person better off (although it obviously can make some persons better off, immigrants for instance). “Income” includes both wages and welfare benefits or other government transfers. Another preliminary remark: it’s wrong to think that growth automatically and by definition makes everyone – and hence also the poor – better off. It just makes the average person better off. That means that it can also in some circumstances make some people – e.g. the poor – worse off. Growth numbers are silent about the distribution of the effects of growth.

The question which the paper tries to answer is the following. Given that poor people can benefit from economic growth in two ways:

1. either growth “trickles down“: more aggregate national income or production means more jobs, better paid jobs etc.
2. or growth can increase the government’s tax base so that the welfare system can be made more generous,

which of these two mechanisms has been most prominent in the 17 countries examined in the paper?

The answer is “number 2”. Why? Well, in some of the selected countries economic growth was accompanied by a significant rise in low-to-middle household incomes, while in the other countries the effect of economic growth on the incomes of people in low-to-middle income groups was much smaller or zero. If economic growth trickles down (1), then one would assume it trickles down in all or most countries. After all, if growth results in more and better paid jobs for the poor, then there’s no a priori reason why this result would occur in one country but not in another.

The nature of government transfer systems is the reason why the effect of growth on the incomes of the poor is not the same in all countries:

when households on low incomes got better off, it was due most often to a rise in net government transfers. Where net transfers increased, incomes tended to increase in concert with economic growth. Norway, the UK, Sweden, Finland, and Denmark illustrate this pattern. Where net transfers were stagnant, income trends were decoupled from growth of the economy. We observe this in the United States, Canada, and Switzerland. This is an important finding. It means that, as a general rule, growth has not trickled down to low income households through wages or employment. And it means that, when government transfers haven’t grown, wages and employment haven’t stepped in to take their place. (source)

Looking at all this from the perspective of the causes of poverty: it’s clear that poor economic growth in wealthy countries cannot, by itself, explain poverty, because these countries can witness both growth and stagnation of the lowest incomes (as a result of their failure to implement the necessary transfer programs). Hence you can have growth without poverty reduction. If lack of growth is the main cause of poverty, then growth would by itself and automatically reduce poverty. We see that this is not the case.

In poor countries, on the other hand, growth can perhaps be sufficient. Those countries start from a lower base and more can trickle down. A lack of growth can, therefore, explain the persistence of poverty in developing countries, but probably not in developed countries. The latter have a basis of wealth that is large enough to fund welfare programs even if growth is poor. Growth helps to make this funding easier, but it’s not really necessary. A more progressive tax system, coupled with some good legislative will, can also do the trick.

More here.

Income Inequality (23): Income Inequality and Poverty

At first sight, income inequality and poverty are completely different things. Poverty is clearly a human rights issue, while income inequality is clearly not, at least not directly (it can have an impact on some human rights). Income inequality is a relative indicator, not an absolute one, and is, for this reason, claimed to be not about poverty at all. Poverty, it is said, is about absolute deprivation and is a lack of the resources necessary to satisfy certain basic needs. Income inequality just describes the unequal possession of resources, basic or otherwise. And indeed, it’s possible to imagine a very rich society in which no one is poor in the sense of lacking basic resources, but in which the distribution of resources is very unequal. Vice versa, there may be countries in which everyone is (almost) equally poor.

However, if we compare countries, we see that the more unequal a society, the larger the numbers of people suffering from poverty. Does that mean that high income inequality leads to more poverty? Not necessarily. That would probably be the case if we saw that a country’s poverty rate grows with increasing inequality. But that doesn’t happen:

If we look across the rich nations, it turns out that there is no relationship between changes in income inequality and changes in the absolute incomes of low-end households. The reason is that income growth for poor households has come almost entirely via increases in net government transfers, and the degree to which governments have increased transfers seems to have been unaffected by changes in income inequality. …

In some countries with little or no rise in income inequality, such as Sweden, government transfers increased and so did the incomes of poor households. In others, such as Germany, transfers and the incomes of low-end households did not increase.

Among nations with sharp increases in top-heavy inequality, we observe a similar disjunction. Here the U.S. and the U.K. offer an especially revealing contrast. The top 1%’s income share soared in both countries, and through the mid-1990s poor households made little progress … But over the next decade low-end American households advanced only slightly, whereas their British counterparts experienced sizable gains [thanks to the Labour government, FS]. (source)

So, in other words, there are countries with soaring inequality that still manage to make the poor better off in absolute terms (not in relative terms obviously) through redistribution. Other countries that witness the same evolution of inequality don’t make their poor better off. And trickle down also doesn’t seem to work, by the way. Vice versa, the less unequal countries also differ in the way they treat the poor. Income inequality doesn’t produce poverty because it doesn’t affect the welfare state.

It’s often argued that income inequality not only fails to produce poverty but actually helps to reduce it. That argument goes something like this. High levels of income inequality – and therefore high wages at the top – are necessary for economic growth. If the top economic performers are allowed to earn very high wages, they will have an incentive to produce and innovate. That will lead to economic growth, which will in turn, through a trickle down mechanism, benefit everyone, including the poor and those earning very little.

However, from the quote above it follows that it’s government transfers rather than automatic mechanisms that have helped the poor during the last decades of increasing inequality. If inequality by itself would reduce poverty, these government transfers would not have been necessary. An increase in income inequality by itself does not improve low-end incomes, as is shown by the example of the US.

And even if it could be shown that rising inequality pushes up the absolute income of the poorest, there are other reasons to object to inequality (such as this for example).

The Failure of “Trickle Down Economics”

Trickle Down Economics, also called Reaganomics (due to its association with the policies of Reagan and Thatcher) or supply-side economics, is the theory according to which policies destined to alleviate poverty and redistribute wealth are unnecessary and even counterproductive. The rich should be allowed to become even more wealthy, by imposing very low tax rates on high incomes (or a flat tax for example) rather than using the tax system to redistribute wealth. The result will be that their wealth will “trickle down” towards those who are less well off.

When government policies favor the wealthy — for example, via tax cuts for upper-income classes — the increase in wealth flows down to those with lower incomes. That’s because the rich are more likely to spend the additional income, creating more economic activity, which in turn generates jobs and eventually, better paychecks for the less well-off. Michael S. Derby (source)

All boats rise on a rising tide. Redistribution is counterproductive because it will take away the incentives to do well, and hence also take away the possibility of wealth creation and subsequent automatic wealth distribution through “trickling down”. All this is reminiscent of laissez-faire and the invisible hand theory.

Reagan’s trickle down policies in the U.S. can still be felt today:

According to the Tax Policy Center, the top marginal tax rate in the U.S. stood at 70% when Reagan was elected in 1980, falling steadily to 28% by 1989, before it began to rise modestly. The top marginal rate now stands at 35% against a peak of 94% in 1945. (source)

These tax cuts were implemented with the support of the Democrats in the House, which explains why they have been upheld all these years. The result of this was, unsurprisingly, a higher concentration of wealth in fewer hands:

In the period since the economic crisis of the early 1970s, US GDP has grown strongly, and the incomes and wealth of the richest Americans has grown spectacularly. By contrast, the gains to households in the middle of the income distribution have been much more modest. Between 1973 … and 2007, median household income rose from $44 000 to just over $50 000, an annual rate of increase of 0.4 per cent. … For those at the bottom of the income distribution, there have been no gains at all. … incomes accruing to the poorest 10 per cent of Americans have actually fallen over the last 30 years. John Quigging (source)

This is already part of the refutation of the doctrine. Obviously not all boats have risen on the same tide. But if you don’t believe this, there’s a paper here and a blogpost here arguing against the doctrine in a more intelligent way. Maybe “spreading the wealth around” a bit and imposing some tougher taxes on the rich isn’t such a bad idea after all. I mean, the “tricklers” have had decades to prove their point, and failed; maybe now it’s time for the “spreaders” to have a go.